Today, CNBC‘s Steve Liesman interviewed San Fran Fed President John Williams. In a swipe at Fed gallows humor, President Williams presented Liesman with a T-Shirt that said the Fed was DATA DEPENDENT. The humor part was Williams’s effort to cut-off Steve Liesman’s well choreographed question which amounts to: “Come on, John, share your inside view about the possibility of a RATE RISE at the next FOMC meeting (just between us, John).” So as to make sure that Liesman understands the consistent answer: It is data dependent. If the FED wants to create some jobs it can send everyone with a bank account a free “Data Dependent” shirt, compliments of their regional Federal Reserve. All sarcasm aside, President Williams’s view puts added importance now to the inflation data on Friday and of course the retail sales input on Wednesday. The consensus on the CORE RETAIL SALES is 0.3% increase so a strong number would be above 0.6%. If the theory of data dependence holds then it should be the SHORT END of the curve that gets sold and here is my reasoning: The 2/10 and 5/30 parts of the yield curve have steepened dramatically during the last two months as the market accepts the fact that the recent bout of weak economic data has pushed the FED further away from raising rates.

The market is worried that the FED will wait too long and the threat of inflation increase, thus there has been a great deal of selling of the long end of the bond market. If the DATA improves and the threat of an earlier FED rate rise increases, the curve OUGHT to flatten as the short-end bears the brunt of investor selling. The inflation issue will be tougher for the market to handle because the FED will maintain it has a DUAL MANDATE:concern for JOBS and INFLATION. The question is for the market: Which mandate should the Fed choose to most closely adhere. As I wrote last week, I believe that the FED would like to raise rates as soon as possible in order to test its mechanism of the O/N RPP/IOER to control overnight reserves. It is a difficult operation to thread the needle of getting off the ZERO INTEREST RATE floor. More on this issue will follow this week.

***China lowered the interest rates on bank loans and deposits, again. In an effort to ease pressure on Chinese borrowers the PBOC lowered rates by a small amount. Unlike previous times, the market response was MUTED. The Chinese YUAN barely moved and more importantly the precious metals failed to rally and even COPPER‘s response was barely unchanged. It seems that the PBOC will have to become ever more aggressive if it wishes to generate some enthusiastic market response. In the realm of currency, the Australian dollar, which tends to responds positively to any type of Chinese stimulus barely reacted. Just something to keep in mind.

***In an effort to prevent boredom about the media’s reporting on Greece and the EU, there were two letters to the Financial Times’ editors in Friday’s edition that shine light on the difficulty of the present Greek negotiations with the Troika. A large part of the current impasse is that the IMF maintains its bailout of Greece should be repaid in full for the IMF is not just any creditor and its covenants demand that it be repaid in full. Letter number one is by David Owen and Robert Skidelsky, both members of the House of Lords and Lord Skidelsky is the biographer of Keynes. In writing about the IMF‘s pushing for other creditors to absorb a Greek debt restructuring the writers note: “Greece was not that indebted to public entities before that. The mistake was the 2010 bailout of the banks, as part of which Europe imposed swinging austerity on the Greeks. Now at the eleventh hour it is imperative that the IMF takes action and the EU and other governments take their hit, while taking seriously the Syriza government’s alternative reform programme.”

In a second letter equally critical of the present process of squeezing Greece, a Professor from the University of Athens, Nicos Devletoglou, sheds light on the reality of the U.S. arbitrating the ongoing debt negotiations: “In the trying circumstances, however, there is also real hope of saving the day: notably, a major independent arbitration or mediation initiative is likely to come from the U.S.–considering the intensified flow in recent weeks of consistent advice from the U.S. Treasury to both sides in a spirit of remarkable goodwill.” The resolution of the stalemate will fall to the U.S. because the politics of an unanchored Greece in the southern Mediterranean will play havoc with U.S. and Nato foreign policy and military plans. Besides, the U.S. with veto power in the IMF will be able to work behind the scenes to find a face-saving device for Christine Lagarde and the IMF.

Bottom line for Lagarde is that she never should have had the IMF join the Greek bailout and left it a pure European problem. But because Director Lagarde had served as the Finance Minister of France prior to her role in the IMF, French and German banks were massively on the hook for Greek debt, which the bailout helped move from private to public institutions. This does not absolve Greece of its liability but does shed some light as to why a restructuring is not out-of-order–Syriza does have a moral leg to leaving a reason for resolution in a more equitable outcome. It does not have to be all or nothing for the participants.

Yra- The other possible reason for the yield curve steepening is that holders of long Treasuries bonds are concerned about credit risk. With the condition of the Treasury balance sheet, there could be problems at the next severe recession, and they may be concerned about getting their money back, or getting repaid in Weimar dollars.

I am not saying this is what’s going on…..I’m not sure.

That said, some indicators of inflation have been going up (such a s the breakeven rate on TIPs), which supports your thesis. But when you look at long term commodity charts, such as copper, it appears inflation will be going lower.

“The market is worried that the FED will wait too long and the threat of inflation increase, thus there has been a great deal of selling of the long end of the bond market.”

Really? If you think the market is worried about inflation, please explain your definition of inflation. Why can’t “Shocked” have it right? While we are talking about the data the Fed is dependent on, what definition of jobs do you think the Fed uses?

Since the data that matters says there will be no inflation, or jobs that increase income tax revenues, there is no way the Fed will hike rates (at least not based on this dual mandate). So, I’ll ask the question in a different way, if the data on which you think the Fed is depending continues to dictate that the Fed not raise rates, and stocks keep rising because of capital flows, will anyone be wearing those T-shirts in a year?

blacklisted–let me be clear.The yield curve HISTORICALLY has been a great barometer of market sentiment about whether the FED is deemed to be behind the curve whether too tight or too loose–when I speak in terms of inflation and the yield curve it is that the investment world is thinking that the FED WILL ERR on being too loose for too long.Now we can say commodity prices are going up ,going down whatever but that is not always inflation–when prices rise in all classes like the 1970’s it is certainly a sign that the central bank has remained too loose for too long–this present period has been more difficult to judge because as Richard Koo and others have maintained this has been a balance sheet recession in which most economic actors have been repairing balance sheets and deleveraging massive credit financed positions.If this has ended,the FED is going to have to rein in the massive reserves that it has created for a financial system flush with massive reserves will unleash credit upon the economy which will send prices rising in an already “full employment economy”–this is the danger and the market fears that the FED and other central banks know not how to extricate themselves from THE GRAND EXPERIMENT—that is the potential inflation the bond market MAY presently concerned with–